Relative Strength Index (RSI) – Identify Overbought and Oversold Stocks

What is the Relative Strength Index (RSI)?

The relative strength index, also known as RSI is a technical indicator, developed by J. Welles Wilder. It is a momentum oscillator, that measures the rate of rising and falling in the price. RSI oscillates between 0 to 100 and when it goes above 70 it is considered as overbought and if it goes below 30 it is considered as oversold.

J. Welles Wilder Jr. introduced RSI in his book, “New Concepts in Technical Trading Systems”, in 1978. Since then it is one of the most-used technical indicators along with the candlestick chart.

Calculation of RSI

The formula to calculate RSI is:

RSI = 100 – (100/1+RS)

Where, 

RS = Average Gain/Average Loss

To calculate RSI, first you have to calculate the average gain and average loss. It is generally calculated for 14 periods where,

  • Average Gain = Sum of Gains over the past 14 periods / 14
  • Average Loss = Sum of Losses over the past 14 periods / 14

Then divide average gain by average to find the RS. Then put the value of RS in the above formula, you will get the RSI value.

Calculation of RSI using Excel Sheet

Open The spreadsheet below in Excel. The formula for RSI is pre-applied there. Look at the header columns: “Date,” “Close,” “Change,” “Gain,” “Loss,” “Avg Gain,” “Avg Loss,” “RS” and “RSI.” You can change the closing price of the security you want, you will get the final relative strength index (RSI).

calculation of RSI Using Excel

Here is an example, You can Download the RSI Excel Sheet.

What RSI Tells You?

The default period for RSI is 14 in most of the charts, but this can be changed according to needs and uses. The 10-day RSI reaches overbought or oversold levels easily compared to 20-day RSI. The parameter also includes security’s volatility.

A security is considered as overbought if RSI is above 70 and oversold when it is below 30. These traditional levels that most of the technical analyst uses and it can be adjusted according to analytical requirements.

If a security price makes a new high or a new low that isn’t confirmed by the RSI, this could be a signal for the price reversal. If the relative strength index of a security makes a lower high and then follows with a downside move that is lower than the previous low, a Top Swing Failure has occurred and vice versa.

Find Over Bought and Oversold Using RSI
Source Trading view

The above chart is of the Nifty 50 index, where 14 period RSI is applied. As you can see when the RSI went above 70 nifty became overbought and saw a healthy correction (downward movement). Then after a few days it goes below the 30 levels and then saw a good upside movement.

Limitation of the Relative Strength Index (RSI)

  • The Relative strength index compares the bullish and bearish price action and its oscillator that indicate overbought and oversold region can be placed below the chart. Like other technical indicators, RSI signals are most reliable, but after the confirmation in the long-term trend.
  • The regular 14-period indicator trend reversal signals are rare and can be difficult to separate from a false breakout in high volatile securities.
  • Because the indicator displays the momentum, it can stay overbought or oversold for a very long time when the security has significant price action in either bullish or bearish direction. So RSI works in very less volatile securities.

The Bottom Line

RSI is a widely used and versatile momentum oscillator, that stands very time of the test. Despite so much in style and volatility in trades and the market over the years, RSI remains relevant as of now and then.

RSI helps the technical analysts to find relevant trades and earn them a very good amount of money. Overall, it is one of the best technical indicators for short-term traders and intraday traders. 

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